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Abstract

Large US firms, by diffusing embodied technology through trade in intermediates, appear to drive Europe's output over the medium term. We develop a twocountry model of endogenous growth in varieties, cross-country firm heterogeneity and trade to match this evidence. A US TFP slowdown generates a pronounced recession in Europe, while a negative investment-specific shock also imparts a protracted recession in the US since GDP and firm productivity stay below trend beyond a decade. Heterogeneous firms, with endogenously changing productivity cutoffs, and the responses of innovators and adopters determine medium-term adjustment, as import switching processes unfold